In franchise contracts it is common to find the franchisee has the obligation not to engage, directly or indirectly, in any similar business to that of the franchise business model as well as the obligation not to acquire financial interests in a competitor company’s capital.
Although such a contractual provision may pose limits to the entrepreneurial freedom of the franchisee, the legality of such clauses has been acknowledged by doctrine.
What happens if a franchisee unilaterally terminates the franchise agreement before the expiry of the agreed term and opens a new store with a similar or identical activity?
Could we consider that this violates the agreement not to compete? We must look at several factors:
1) Firstly, what position does the franchisee hold in the new business: if he is acting directly, through third parties who represent him or if he is the majority or minority partner in the new business …
2) Secondly, whether the activity of the new company is identical or not to the one which was utilized in the franchise. Here some discrepancies may arise, but the decisive point is if the former franchisee is found to use his know-how in his new business.
The issue could be complicated further if the franchisee is a legal person and it was his partners who have (i) transferred the shares to an individual, and (ii) once the franchise agreement has been terminated on a separate basis by the franchisee (legal person) the premises have been used to open up a new business in his exclusive ownership and with a partially overlapping activity.
In anticipation of all these cases, it is essential to include penalty clauses for breach of contract of non-competition in the franchise agreement, not only for the franchisee (in the case of a legal person), but also for the partners who figure in the contract, and all this is in order to defend the protection of the franchisor’s industrial property rights.